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Turning risk to opportunity

Wherever we turn, risk is high on the agenda. There are always perceptions that risk is increasing, but in reality it probably just changes. Many challenges of the past are no longer significant or relevant; many risks of the future have not even been envisaged.

Business inevitably involves risk and you could say that its management lies at the core of competitive advantage. I think that this issue sits at the heart of the contract and commercial management role – but what position should a contract or commercial manager be taking?

There is a tendency in many standard forms of contract or during negotiations to engage in relatively mindless games of risk allocation. This is done in the name of efficiency and without giving thought to its consequence in terms of missed value opportunities or subsequent impact on the behavior of our counter-party. We know that this approach often makes little sense, but it serves the interests of time and expediency.

Making commitments always carries a degree of risk. Receiving commitments is also risky, since it implies reliance on another party who may not perform. Contracting is often an exercise in minimizing our own commitments and extracting not only commitments from the other side, but also imposing unpleasant consequences for their failure. To some extent, this will always remain a significant component of the contracting and negotiation process.

But I believe that contracts and commercial professionals have another and more valuable role to play. Their skills and experience can lead them to a superior understanding of their own organization’s capabilities, the limits of which place constraints on what can be negotiated. Since competitive advantage comes from superior abilities in risk management, it is my contention that contracts and commercial staff should always be exploring ways to improve their commitment capabilities, making business performance safer, but also making their organization a customer or supplier of choice.

We all like dealing with highly competent people. We are more likely to trust them. The same is true of business. If we are seen as constantly battling to avoid risk, what does that say about our organization and its competence, its trustworthiness?  So for the commercial expert, the opportunity is to identify areas where commitment is valued by our counter-party and seek creative ways to accept it. It is my contention that over time, responsible risk adopters will always win out over risk avoiders.

Procurement’s growing role: is it sustainable?

On Spend Matters, Peter Smith recently made interesting observations about the growth of Procurement influence. He suggests that two major factors have raised its profile and purpose, one being the dramatic growth of external spend (largely driven by outsourcing) and the other being globalization. Each of these has taken organizations into uncharted waters, stretching internal skills and experience and exposing unfamiliar risks.

One obvious effect of this shift has been the centralization of most Procurement functions, as management realised the importance of greater controls, more consistent policies and the consolidation of spend in a group outside the control of individual business units.

But as Peter points out, spend volume cannot go on increasing for ever and many of the risks associated with global procurement are becoming better understood and managed. So what is the next big thing that will maintain the influence of the Procurement function – or isn’t there one, was this growth just an aberration?

This is certainly a point of growing debate, with more and more forums reflecting the apparent uncertainty and insecurity of the Procurement function. I have been involved directly in three such discussions in the last week – one with Proxima on a webinar, one at the Zycus ‘Horizons’ conference and most recently at this week’s Virginia Public Procurement Forum. CIPS has even advanced the idea that anyone buying goods or services should be a licensed practitioner – hence trying to institutionalize the function, rather than address the more difficult question of its real or sustainable value. Unlike the lively and motivational discussions at the events I mentioned, the licensing route seems to me entirely the wrong way to go – and indeed is in direct contrast to the general trend of liberalization within professions.

A point that is not often mentioned is the extent to which other (and much more established) professions are asking themselves similar questions. The reason for this is not hard to find; networked technologies replace the need for many lower level activities and also increase access to knowledge. McKinsey says that 47% of professionals will not be needed in a few years time. Hence, Procurement should survive only if it is needed; it cannot succeed in fighting the tide of ‘knowledge commoditization’ and task automation.

So what activities are needed? Certainly there is value in market evaluation and research, which is increasingly important as organizations race for competitive advantage and innovation. There is tremendous value in aligning business requirements with market capabilities, a frequent source of value loss in today’s supply management. There is value in assembling and reconciling stakeholder interests and perspectives, an often contentious, time consuming and incomplete activity. There is value in negotiation and in ensuring effective implementation of resulting agreements, focusing on users and their needs. Finally, there is value in overseeing results and outcomes, including avoidance of problems, resolution of disputes and dissemination of learning. Procurement is already active in some of these areas, but in many it is seen today as just one of the stakeholders or even an obstacle, rather than an organization that effectively coordinates, exercises judgment and takes responsibility for outcomes.

I believe there is a sustainable role for Procurement, but it will be quite different from the role of the past and it will encounter competition from others also seeking self-preservation. It also demands a radical shift from the control and compliance mentality that has dominated many of the discussions and growth of the past. So there is some urgency in moving ahead. But right now, I see no consensus of vision either within the practitioner community or among those who represent them - and that is a real threat.

Successful negotiation

“We have to move from an environment where success is measured on concessions won, to where it is gauged by goals achieved, benefits that are shared’.

This statement was made by the head of contracting for a major state agency during a conference I am currently attending. I like the way it is expressed. On one level, it appears simply to be a statement of win-win, but I think it injects an important additional ingredient to that win-win calculation.

The problem I have with books like Getting to Yes is that they tend to see the moment of gaining agreement as the point at which value is realized and divided. In a spot trade, perhaps even in a typical commodity contract, that may be true. But increasingly we are negotiating agreements for solutions, services and long-term projects where results are only evident over time – sometimes a very long time. In this environment, we have to evaluate negotiation success by different criteria – essentially, as the initial quote describes, by ‘goals achieved, benefits shared’.

This is why the subjects that lie at the heart of good negotiations today are changing. They focus far more on the principles of how the parties will work together, how they will identify risks or challenges, how they will handle the need for change. Negotiators are establishing a roadmap or a blueprint for future engagement, not just a set of rules for a short-term transaction.

If negotiators remain fixated on winning points and gaining concessions, it means they will fail to establish the on-going governance and performance principles necessary for success. It also creates an environment where cooperation is threatened, where the party which was forced into concessions is seeking to gain revenge, or to rebalance the relationship.

IACCM research points to high – and in some organizations increasing – percentages of agreements that fail to deliver business goals and where neither party achieves expected benefits. I suspect that an investigation of their negotiation strategies would point to a traditional approach where negotiations proceed issue by issue, where there is no discussion of impact on value or behaviors, and where the focus is often on compliance and a ‘battle of the forms’. If your organization is one of those, it is time to push for change.

Performance Based Contracts: Are they worthwhile?

IACCM recently completed research with Newcastle University Business School and the University of Paderborn, exploring industry experience with performance or outcome-based contracts. Complete findings will be published shortly, but the results indicate that the use of performance or outcome based contracts remains relatively immature, even though experience in many cases is favorable. There is particular evidence that this approach to contracting results in more collaborative and longer term relationships, implying that they are capable of delivering increased value for both parties. However, success typically requires a level of investment by both parties in appropriate skills, processes and supporting tools or systems. Also, the level of adoption at present appears greater in contracts where payment is based on use, rather than those where payment is based on results over time.

Therefore any move by industry – or individual contractors – towards this contractual model requires a degree of planning and capability review; it also requires more careful and holistic review of trading partner culture, behavior and capabilities to ensure each party is equipped to operate with these models.

The survey – which gathered input from more than 250 organizations – reveals that most performance-based contracts are being constructed through ‘trial and error’ methods and then demand ‘improvisation’ for their on-going management, often including the need to challenge or change internal policies or practices.

Many performance / outcome based agreements today are quite rudimentary and for relatively standard, low-value services. This is reflected in the payment schedules, where rewards are mostly not based on outcomes, but on pay by use. This confirms the fact that many performance based agreements are more about turning services into commodities, rather than operating at a strategic level of delivering high value outcomes.

However, with some two thirds of respondents reporting favorable or very favorable results, it is clear that interest in this relatively immature type of contract will continue to increase. IACCM’s work has been focused on the approaches and structures needed to support success.

Are organizations incapable of running successful trading relationships?

Yesterday I was involved in a webinar discussing the future of Procurement, which IACCM ran in partnership with Proxima. I very much enjoyed the discussion and thought that many good ideas emerged, but I was left with a nagging doubt over whether we had really addressed the key issue.

The program featured an extremely talented and successful CPO. He explained that his ability to contribute increasing value to the business was being achieved in large part through the development of talent and skills within the Procurement function. But he then made clear that most of this was due to hiring in a diverse range of professionals with no procurement background – for example, lawyers, accountants, risk and compliance experts.

Essentially, as I commented on the program, it sounds as though he is actually building a ‘business within a business’. And while I can see the short-term attraction of this, I wonder whether it is a sustainable model and whether it actually addresses ‘the future of procurement’.

The big challenge for successful procurements (which is similar to the challenge for successful sales) is the need to integrate internal resources and stakeholders, to reach consensus and ensure that commitments are supported. Of course, one way around this is to avoid the stakeholders. That certainly increases the speed of decision making – but usually spells disaster when it comes to implementation. Another route – which I suspect this CPO is pursuing – is to create a shadow organization, which can also make some decisions more independently, but may also be more effective in communicating with internal business groups and functions because they speak the same language.

The problem with this approach is that over time, there tends to be contention over authorities. For example, a lawyer in Procurement is not a Corporate Counsel and their authorities are accordingly restricted. For the individual in Procurement, those limitations can become galling and they also lose a natural career path within their own functional discipline. And from a business perspective, the perception of duplication of effort raises questions over costs and efficiency.

However, a different point of view could be to recognize that the biggest challenge to good trading relationships is the existence of internal silos and specialisms. This realization might lead to the creation of Procurement and Sales Contracting groups drawn from a diverse array of functional skills so that they can perform precisely the accelerated role and interactions outlined above. Perhaps rather than having people build a career in Procurement or Sales Contracting, they are individuals assigned from their function for a period of time, as a career broadening and development move. Indeed, this might be an excellent way to spread commercial skills and competence through the business. However, ultimately it would also be a recognition that there really is no such as thing as a “Procurement” profession – it is rather an amalgam of diverse business skills, employed to overcome the weaknesses created by today’s functional silos.

Coping with complexity

The issues created by complexity are at the forefront for most contracts and procurement professionals. The reasons for this are made evident in a recent article in Strategy+Business, which outlines three distinct levels of complexity and describes each in terms of the extent of interconnections and interdependencies. It highlights the third tier is reached when interactions become unknown or unpredictable – in other words, our ability to predict or build effective controls are limited.

This topic is very interesting because there is no doubt that contracts sit at the nexus of complexity and are tools which try to make sense of it. In fact, the three designations of complexity type listed in this article could be a very effective way to do contract and contract management modelling. In the realm of simplicity, standard templates can work. But attempts to impose the same standards in more complex situations will inevitably create problems. So contract design and associated management systems must be attuned to the complexity model.

When I led contracts re-engineering work at IBM almost 20 years ago, we actually stumbled onto this thinking. We categorized contracts into three ‘bucket’ - ‘commodity’, ‘integrated solution’ and ‘custom / first of a kind’. The first was a simple and independent product or service sale or acquisition; the second was a combination of products or services, which created interdependencies and more complicated commitments, but which had been done before and therefore risks were known and manageable. It was the third category that represented true ‘complexity’ because it involved levels of innovation and customization that took us into the realms of the unknown.

By thinking this way, we were able to identify the portfolios of contract terms needed for differing situations and to design contract models that would adjust to the nature of the transaction. Systems support and required skill levels could also be attuned to the varying levels of complexity and therefore directly linked to the management of risk.

A further benefit of this approach was that it provided a simple explanation to senior management about the role and purpose of contracts and the contract management function. They could quickly grasp the relevance of both in assisting management of the business. This thinking has continued to influence our work at IACCM, as we look at best practices in process, organization and contract template design.

Increasing influence

According to research by The Hackett Group, the second highest priority for Chief Procurement Officers in 2015 is to increase scope and influence. This was among a range of data presented today at the Zycus Horizons conference in Florida.

This finding begs a number of questions. First, why do CPOs see raising their influence and expanding their scope as a priority? Beyond personal or functional ambition, is any one actually calling for an extension to their role? What benefits are expected to flow as a result? Presumably this ambition is driven either by a perceived need to fill gaps, or by the belief that the work currently undertaken by others can be done better by Procurement.

The second question relates to these areas of benefit. One would expect that other 2015 priorities would give some clue as to the new values that will be achieved as a result of greater influence. Reduced costs tops the list – and this is certainly not a new area of endeavor. Reduced supply risk comes third – again, hardly new, but certainly an area where there is room for improvement. At 32%, ‘deeper influence on complex market spend’ is a legitimate ambition for many; complex relationships often operate with limited Procurement involvement. Innovation – an area which you would think could yield significant extra influence – comes in at only 21% on the list of priorities.

So there are some useful indicators here regarding the possible approach to increased influence and scope. The main opportunities are likely to be earlier engagement and increased market insight, selecting suppliers on value and competence more than on price. And then also expanding performance oversight and the management of on-going change, including innovation. Together, these areas would actually tackle all of the objectives listed above.

But the question remains, does Procurement have the skills and tools needed to execute on these improvements, or the ambition to acquire them? I will comment on that tomorrow, in my second report from Horizons 2014.


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